Whisper, Winks and Nods — The Value of Intangible Research

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New York, NY – Some market participants suggest that one reason that buy-side firms may have “overpaid” for sell-side research in the past is because of what might be termed “intangible research” — the value of first calls, reports on market color, market insights, etc.

One person who holds such a view is long-time blog reader and regular commentator on the investment research industry, William George, of Blue Sky Research.  The following post is Mr. George’s comments on this topic.

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In the context of your article (Buy-Side Demand for Sell-Side Research Expected to Wane), it seems to me that there is a dimension of sell-side research that, to a large degree, has escaped significant discussion or scrutiny, and which has even escaped adequate description; because it’s so difficult to conceptualize and define. I guess I would call this type of research the whisper, the wink, and the nod, or for a less pejorative name I might call it intangible research.

Buy-side traders and investment managers have always directed order-flow (and the resulting commissions in excess of the costs of execution) for good ideas, market insights, first-calls and ‘market-color’ reports which might be helpful to their investment management objectives. Over the last several years, the rapid growth of hedge fund assets and hedge fund trading techniques has made this variety of research very popular, and the advent of CSA / CCA’s, with executing brokers’ at the nexus of significant order flow, has increased the use of this ‘intangible research’ for both hedge funds and for traditional institutional advisory structures.

Furthermore, I’ve always thought such ‘intangible research’ has contributed to what you and others call over-payment for research, and it has complicated the accounting for bundled undisclosed research services. Additionally, it seems that, because such intangible research is not objectively described or priced, it complicates tests for Section 28(e) compliance and makes the enforcement of Section 28(e)* extremely difficult (in fact, it makes it impossible).

I believe the exchange of clients’ commissions for what I call ‘intangible research’ will increase in the future. Particularly if this variety of research continues to escape description, quantification and separate pricing. Also, I believe this ‘Intangible research’ is one significant element in the commission obfuscation you mention in your article. Any analysis which attempts to define, identify and describe this type of sell-side research will contribute to an understanding of the competitive disadvantage independent research providers struggle against when compared to sell-side research providers. Such definition, description and analysis will also assist institutional clients and their fiduciaries in the measurement of the benefits received for their institutional brokerage commissions.

It seems to me that questionnaires, studies and discussions about research value, Section 28(e) compliance, and the appropriate use of institutional clients’ brokerage commissions could be greatly improved by attempting to describe and quantify what I call intangible research.

* That is, the even-handed enforcement of sell-side research costs vs.independent research costs.

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